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Sec. 6676: There's a New Penalty in Town

The Small Business and Work
Opportunity Tax Act of 2007, P.L. 110-28, §8247(a),
added a new taxpayer penalty under Sec. 6676 for
erroneous refund claims, effective for claims filed
or submitted after May 25, 2007. Under this
provision, if a taxpayer makes a claim for refund or
credit with respect to income tax for an excessive
amount, the IRS may impose a 20% penalty on that
amount unless the taxpayer shows that the claim for
such excessive amount has a reasonable basis. Sec.
6676(b) defines “excessive amount” as the amount of
the claim or refund for any tax year that exceeds
the amount of the claim allowable under the Code for
the tax year. There is no statutory reasonable cause
exception to the Sec. 6676 penalty.

The Sec.
6676 penalty does not apply to the portion of the
excessive amount subject to a penalty under Sec.
6662 (accuracy-related penalty on underpayments),
Sec. 6662A (reportable transaction understatement
penalty), or Sec. 6663 (fraud penalty). In addition,
unlike the penalties under Secs. 6662, 6662A, and
6663, which are subject to deficiency procedures,
the Sec. 6676 penalty is immediately assessable and
must be paid upon notice and demand. This means that
the taxpayer’s ability to challenge the penalty
before paying it may be severely limited unless the
IRS provides an administrative process to do so.

Need for Guidance

The IRS
has not provided guidance on the Sec. 6676 penalty,
despite the fact that the penalty has been included
in its Priority Guidance Plan every year since the
penalty’s enactment in 2007. Thus, the application
of the Sec. 6676 penalty is fraught with
uncertainty. Taxpayers and IRS personnel need
guidance to ensure that the IRS is fairly,
correctly, and consistently applying the penalty,
particularly given that it is an assessable
penalty.

If proposed regulations are not
possible at this time, the government has other
options. When needed, the IRS and Treasury have
provided useful interim guidance that the public can
rely on. The IRS has also provided immediate
guidance by providing instructions to IRS personnel
and making these instructions public. In whatever
form, there are four Sec. 6676 issues that are in
need of immediate guidance.

Definition of reasonable basis:
Sec. 6676 is not applicable if the
claim for the excessive amount has a reasonable
basis. The statute is silent as to what “reasonable
basis” means. However, Regs. Sec. 1.6662-3(b)(3)
defines the term for purposes of Sec. 6662. Although
on first blush it may appear that wholesale adoption
of the Sec. 6662 definition of reasonable basis for
purposes of Sec. 6676 is the correct approach, on
reflection it may be better to tailor the definition
to the role it plays with respect to each
penalty.

Unlike reasonable basis in Sec. 6662,
which is merely a prerequisite for disclosure to
operate as penalty protection, under Sec. 6676
reasonable basis is the sole means by which the
taxpayer can establish that the amount claimed for a
refund was appropriate and by which the IRS has the
flexibility to fairly and effectively administer the
penalty. Given this difference, it would be more
appropriate in Sec. 6676 to begin with the
definition of reasonable basis in Sec. 6662 and then
tailor the definition to correspond with the role it
plays in the context of the Sec. 6676 penalty.

Preassessment procedures: The
Sec. 6676 penalty is immediately assessable, and
payment is due upon notice and demand. In light of
the fact that the penalty does not apply to an
excessive amount that has a reasonable basis, it is
important that the taxpayer’s rights to challenge
the penalty are protected by providing procedures
for a full administrative review, including
consideration by Appeals. Therefore, the IRS should
develop procedures allowing for notice and
opportunity to meet with the IRS before assessing
the penalty.

Coordination of penalties:
Coordination between an assessable
penalty, such as Sec. 6676, and penalties subject to
deficiency procedures, such as Sec. 6662, can be
complex. This is particularly true if the taxpayer
makes the claim for refund that is subject to the
Sec. 6676 penalty on an original return that is
being examined. IRS personnel need guidance to help
them understand the nuances regarding which portion
of the amount being disallowed is subject to the
Sec. 6676 penalty and which portion is subject to
deficiency procedures. In addition, guidance is
needed to ensure that the protections afforded by
deficiency procedures are not undermined by
premature assertion of the Sec. 6676 penalty.

Application in settlements: It
is not unusual for the IRS and the taxpayer to reach
an agreement so that the amount refunded to a
taxpayer for a particular item is less than the full
amount requested in the refund claim. The reasons
for such concessions vary depending on any number of
factors, including the parties’ consideration of the
costs and hazards of litigation.

The fact
that the IRS could apply the Sec. 6676 penalty to
the portion of the refund claim conceded by the
taxpayer in order to obtain a settlement adds a
detrimental new calculus to the settlement process
that may deter compromise, encourage taxpayers to
seek all-or-nothing settlements, and increase the
likelihood of litigation. On the other hand, agents
may also use the mere specter of the Sec. 6676
penalty as leverage to obtain concessions the
taxpayer might not otherwise have made. Guidance
preventing IRS personnel from asserting the Sec.
6676 penalty absent an affirmative finding that the
entire claim for refund for a particular item has no
reasonable basis would go far toward eliminating
these issues.

Conclusion

Application of the Sec. 6676 penalty is fraught
with uncertainty. Taxpayers and IRS personnel need
guidance to ensure that the penalty is being fairly,
correctly, and consistently applied. After three
years, it is not unreasonable to expect guidance on
this penalty, given the uncertainty surrounding it.
When needed, the IRS and Treasury have provided
useful immediate guidance that is available to both
the IRS and the public. Hopefully, such guidance
will come soon for the Sec. 6676 penalty.

EditorNotes

John Miller is a faculty instructor at
Metropolitan Community College in Omaha, NE.
Rochelle Hodes is with PricewaterhouseCoopers LLP in
Washington, DC, and is a member of the AICPA Tax
Division’s IRS Practice and Procedures Committee.
For further information about this column, contact
Mr. Miller at johnmillercpa@cox.net.

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